Bank Of England: Minutes Of The Productive Finance Working Group - 28 July 2021

Agenda

1. Competition law reminder by Simmons & Simmons LLP

2. Discussion of the recommendations in the draft Productive Finance Working Group report

3. Next steps

Minutes

Item 1 – Competition law reminder by Simmons & Simmons LLP

Simmons & Simmons LLP set out the legal obligations of all members of the Working Group relating to competition law.^footnote[1] They reminded members that it is their responsibility to meet their legal obligations and to take their own legal advice.

Item 2 – Discussion of the recommendations in the draft Productive Finance Working Group report

Andrew Bailey welcomed the meeting participants and set the objectives for the meeting – to discuss the key messages and recommendations developed by the Technical Expert Group (TEG) in the draft Productive Finance Working Group report and agree next steps.

The Steering Committee (SC) chairs^footnote[2] reiterated the importance of the Group’s work to facilitate greater investment in long-term, less liquid assets and the benefits this would bring for pension savers and the wider economy. They thanked members of the SC and the TEG for the excellent progress they have made and support they have given in writing the draft report and developing the recommendations contained in it.

The recommendations had been grouped into four buckets: focus on long-term value for DC pension scheme members; building scale in the DC market; a new approach to liquidity management; and widening access to less liquid assets to a broader set of investors.

SC members supported all of the recommendations and discussed them, in turn.

Focus on long-term value for DC pension scheme members

As the DC pension industry has grown, and as most pension savers do not manage their own investments, it has sought to ensure that costs are low. This was necessary against a backdrop of legacy products that had relatively high cost without necessarily generating sufficient value for members. However, as the industry matures, an excessive focus on cost alone could become a missed opportunity to secure long-term value for members in the future.

There was general agreement that shifting the focus away from cost to long-term value for members was crucial to support investment in a broader range of assets, but such a shift would require concerted action by all key stakeholders.

Pension schemes are expected to focus on member outcomes in carrying out their fiduciary duty. Some members, therefore, thought that there was a greater onus on the Group and the industry, more generally, to make a positive case to schemes that investing in less liquid assets may be in their members’ interests and that the risks can be managed (see below). It was important to recognise, however, that: such investments/some less liquid assets may not be appropriate for all schemes; and the broader economic benefits of such investments were of secondary importance to schemes. The Pensions and Lifetime Savings Association, the Association of British Insurers, theCityUK and the Investment Association (IA) agreed to develop the case for schemes to invest in less liquid assets.

Some members felt that the focus on cost alone was so entrenched, that greater regulatory action was required to facilitate more investment in less liquid assets. One suggestion was a requirement that pension schemes should actively consider such investments and, if they choose not to, explain why. However, there was no consensus on this, as other members thought that it should not be the role of Government or regulators to direct investments in particular asset classes and were concerned that this would further increase the administrative burden on pension schemes.

There was a range of views on how and what changes to performance fees might help. The Group welcomed the Department for Work and Pensions (DWP)’s recent reforms to introduce smoothing into the Charge Cap. However, some members thought that this did not go far enough and favoured excluding performance fees from the cap where they are associated with greater long-term value for members. This would give schemes more scope to invest in less liquid assets without breaching the cap. Leaving the Charge Cap aside, one member expressed scepticism about the value and necessity of such fees at all and thought the solution was for asset managers, consultants and DC schemes to work together to develop innovative and flexible methodologies for performance fees that are better suited to DC schemes. There was no consensus on either of these proposals, but the SC agreed to continue to develop recommendations on them with the aim of gaining greater support. Simmons & Simmons offered to work with others on performance fee methodologies.

Several members also said that Trustees should put greater focus on optimising expected future net risk-adjusted returns for members and monitor long-term returns, rather than focussing on those over the next year or two, which is currently often the case.

Several members highlighted the important role of consultants, who advise Trustees in their investment allocations, in shifting the focus to long-term value. Willis Towers Watson indicated that they would be happy to take forward the recommendations relating to consultants.

Building scale in the DC market

The DC market is characterised by a long tail of small schemes. This makes longer-term investments harder, because smaller schemes do not have the bargaining power to negotiate appropriate fees when investing in less liquid assets or the capacity and expertise to make complex investment decisions. As a result, a meaningful, diversified allocation to less liquid assets is only currently possible for a small number of the largest UK DC schemes.

There was broad support for the two main recommended ways to overcome the scale barrier. The first is for DC schemes to consolidate, which the DWP is already driving and the Group supports. In particular, an assessment of a scheme’s ability to deliver value and access a diversified range of asset classes at its current scale should be a key factor in its consideration of whether to consolidate. The second is to make less liquid investments more accessible to smaller schemes. A wider range of fund structures can support pooling of multiple assets into a single fund vehicle. The Long-Term Asset Fund (LTAF) will be important in supporting this.

Some members noted that consolidation is only a route to better member outcomes if it is associated with improved governance and greater long-term value for members.

A new approach to liquidity management

Greater investment in less liquid assets increases the importance of robust liquidity management, given that many of these assets cannot be bought and sold on a daily basis. A broader range of DC schemes can find approaches that enable them to invest in less liquid assets as part of a diversified portfolio, while also meeting liquidity needs of DC scheme members.

Alongside support for Trustees managing liquidity at the DC scheme level, they would also need a range of products that provide access to less liquid investments. In addition to existing opportunities, the Group has further developed the key elements of the LTAF, which is specifically designed for investment in less liquid assets, and requires aligning redemption policy of the fund with liquidity of its assets.

To facilitate appropriate liquidity management and give Trustees greater confidence in investing in less liquid assets, there was broad support for industry and trade bodies to develop guidance on good practice on liquidity management at a fund level, in collaboration with the FCA and the Bank of England. This guidance should focus on appropriate ranges for dealing frequency and notice periods for the different asset types for the LTAF.

Given the industry’s current reliance on daily dealing, a mindset shift was required. It was vital that the new liquidity toolkit was transparent, flexible, effective in bad times, as well as good, and investors had full confidence in and understanding of them. Some members also asked the regulators to play a bigger role in helping industry develop and regulate the tools, including putting them into the broader context of their work on liquidity management for the open-ended funds.

The IA, BVCA and abrdn agreed to work with other stakeholders to develop this liquidity toolkit and guidance.

Widening access to less liquid assets to a broader set of investors

There are a range of ways to invest in less liquid assets, all of which play important roles in meeting the needs of different investor groups. To facilitate the distribution of less liquid assets, including the LTAF, to a broader range of investors including DC schemes and retail, when appropriate, there was broad support for the FCA to consult on changing their rules for investment in less liquid assets through unit-linked funds and review their rules for distribution to appropriate retail clients, respectively. Nikhil Rathi confirmed that the FCA would take these forward to consultation.

Several members thought that it was important to signal the following in the report:

1. in principle, a well-diversified portfolio, which includes less liquid assets, may be appropriate for a wide range of investors;
2. in an environment of low interest rates, which may encourage a search for yield, the LTAF could offer a safe way of achieving that; and
3. the direction of travel should be to make the LTAF available to a broader set of investors, including retail, as long as the appropriate protections are in place.

One member said that the LTAF should not be made available to retail investors at this stage. It should only be considered for retail distribution after it had demonstrated that it was safe in the institutional market in both good and bad market conditions.

One member noted that under current tax rules, investor monies that are sheltered in Individual Saving Accounts would be unable to be invested in LTAFs. However, consideration of tax incentives is not in scope of the Working Group’s objectives, so the Group has not made a recommendations on this.

Item 3 – Next steps

Members were asked to provide further comments on the report and recommendations and expressions of interest to take forward the latter by Friday 6 August. The Secretariat would work with the Technical Expert Group to incorporate these into the final report to be published in September.

The Secretariat would also get in touch with organisations, who agree to take forward the recommendations, to kick off the process of implementing them.

There was widespread agreement that the SC should monitor progress in implementing the recommendations and meet again in early 2022 to do that.